CHAPEL HILL, N.C. – Alphabet’s just-announced 20-for-1 stock split is not the bullish omen that investors are making it out to be.
There are two major arguments being given for why this stock split is bullish for the company GOOG, +8.04% GOOGL, +8.28%, the parent of Google. Neither is compelling. If you had bought the stock because of that announcement, you therefore should reconsider.
Myth No. 1: A stock split signals corporate confidence in the future
This myth is at least based on solid historical evidence. It’s become a myth in recent years because the markets have fundamentally changed.
A stock split used to be a bullish omen because it signaled that management was confident its stock would subsequently rise. Researchers hypothesized that a firm’s managers had a loosely defined “sweet spot” in which they wanted their stock to trade—often around $50 to $75 per share. If its price was well above that, they would split their stock only if they believed the price wouldn’t otherwise fall back into that range.
This signaling effect has become a lot weaker in recent years for several reasons. One is that high-priced shares don’t present any obstacle to institutional investors, which have come to increasingly dominate the market. The second is that retail investors with relatively small amounts to invest are now able to purchase fractional shares through large firms like Fidelity and Charles Schwab SCHW, -0.36%. So there’s nothing stopping even them from investing in a stock as high-priced as Google currently is, at around $3,000 per share.
This chart reflects the declining importance of stock splits. The chart shows the number of high-priced shares among stocks in the S&P 500 index, both in 2010 and today. Currently, for example, more than half the stocks in the index trade for more than $100, versus just 20 at the end of 2010.
Myth No. 2: Stocks rise when added to the Dow industrials
The other reason given for why Google’s split is bullish is that it’s a prerequisite for being added to the Dow Jones Industrials Average DJIA, +0.17%, and being added to the index would attract more investor interest.
The reason this prerequisite even exists is that the Dow is a price-weighted index. If a pre-split Alphabet were added to the Dow industrials, the benchmark’s future performance would largely become a function of how Google does, regardless of how the other 29 stocks in the index perform. That’s something that the selection committee at S&P Dow Jones Indices would be unlikely to allow.
This argument doesn’t stand up to scrutiny. First, a relatively small amount of index fund assets are benchmarked to the DJIA. Just $29 billion is invested in the SPDR Dow Jones Industrial Average ETF Trust DIA, +0.16%, the largest of the ETFs benchmarked to this index. In contrast, assets at the SPDR S&P 500 ETF SPY, +0.55% are around $400 billion, and Google is already one of the stocks in the S&P 500 index.
It used to be true that getting added to a major market average was bullish for the stock that was added. But that stopped being the case a number of years ago, according to a study from S&P Dow Jones Indices entitled “What Happened to the Index Effect? A Look at Three Decades of S&P 500 Adds and Drops.” So even if there were a lot more assets under management at DJIA-benchmarked index funds, it’s not clear that being added to the DJIA would be all that bullish.
The bottom line? Insofar as Google’s stock has rallied solely because of its imminent stock split, odds are good that it will soon retreat to what it would have been without the split.
Mark Hulbert is a regular contributor to MarketWatch. His Hulbert Ratings tracks investment newsletters that pay a flat fee to be audited. He can be reached at firstname.lastname@example.org.
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